This article reflects the outlook for markets for the short, medium and longer term term per Felix Zulauf’s perspective. As usual, Mr. Zulauf covers leading assets like equities, bonds, gold, and also looks at markets in an economic context.
Minor improvements in major economic indicators have led investors to believe that the economy is finally back on track, fostering a false sense of security and encouraging complacency. The rise in bond yields is part of a cyclical bottoming process for rising yields. Rising yields are bad news for equities as most assets are priced off interest. In regards to gold, it has most likely topped on a medium-term basis. However, we could see another short-term bounce and should expect buying opportunities next year and beyond.
Where are the equity markets headed?
The recent sell-off should be seen as the start of something rather than the typical brief dip that one should buy. Felix, in his analysis, had already warned of a medium-term correction in global equity markets and still believes that there is reason to be cautious. This mid-term trend could persist and possibly reach its low prior to the US presidential elections, which, given the dangerous levels of investor complacency developed over recent months, could ultimately cause a sharp increase in volatility.
The “mini bull cycle” that started in Q1 this year, which is expected to continue into 2017, is also a part of a long-term topping process of the bull cycle that started with the 2009 lows. This long term-cycle will most likely be completed next year.
Has the economy really recovered?
Over the last 25 years, the world economy has grown increasingly dependent on China as a major contributing force for growth: as long as China kept growing by around 10% in real terms, it sustained and supported the global economy. Now, however, this vital driver has entered a slowdown phase, with its growth rate reduced to 6-7%, as the official figures state (and could be even half of that in real terms). This vacuum will need to be filled by the world’s developed economies.
On the surface, the EU economy has indeed outperformed expectations, overtaking the US economy, while the EUR/USD declining from 1.60 down to 1.05-1.15 has been a major driver in making Europe more competitive. However, Europe’s leading economic indicators (LEI) do not point to a decisive recovery, but instead a continued slowdown in the region’s economic activity. Germany is perhaps the sole exception, growing at a 3% rate, as a weaker euro boosted its exports and employment figures. The fact remains, however, that a third of German jobs are dependent on the automotive industry, and when this sector slows down, it will have a significant impact on both Germany and their subcontractors in other regions. Still, some fiscal stimulus remains possible from Germany, as the country’s finance minister recently confirmed the government is considering income tax cuts for private households; a plausible measure, in lieu of the October 2017 elections.
Meanwhile, in the US, growth is also expected to remain weak, as all sectors, apart from the consumer, have been slowing down. Substantial improvement would require private investments and this seems unlikely to happen at the moment due to eroding profits.
All in all, it seems that the world economy has settled in to low levels for now, yet the potential for sustainable, real growth is unlikely for the next few quarters. Leading indicators are not as reliable as they once were, while the financial leverage globally is higher than ever before, thus raising serious concerns and risks for the year ahead.
Bond Yields still in a bottoming process
As the global bond market has been fundamentally distorted by Central Bank interventions, some have called it a bubble. Yet Felix sees the trends more as part of a long-term bottoming process, in which occasional sharp yield rises are expected. Nevertheless, their upside is limited by the weak global economy. Although yields could soften once more after the current medium-term rise is complete, it is expected that this bottoming process will continue and yields will be rising through 2017.
When this mid-term yield rise ends, as a result of an eventual increase in volatility indices, the consensus’ hopes of a global economic pick-up will be gone again, as the big-picture outlook is indeed worrisome. Since global debt doubles roughly every decade, the world could go from $200 trillion to $400 trillion by 2025, while money supply injections and systemic leverage will be gigantic. Meanwhile, the rise of populism, nationalism and protectionism in the West, not to mention the rest of the world, has a dangerous inflationary potential as the middle class is expected to continue to shrink.
While gold’s advantage as a protection against aggressive governmental interventions in the economy remains unquestionable, it has recently demonstrated a rather underwhelming performance during this risk-off period in other markets. However, another great buying opportunity lies ahead next year, as well as a multi-year bull market in gold to follow, as we eventually enter a more inflationary era.
During the most recent correction phase, we saw both bond prices and equity markets correcting at the same time. This confirms our strategic view at BFI of the importance of including assets that are uncorrelated with traditional asset classes, such as hedge funds. In addition to our diligent selection process for high-quality hedge funds, and while we continue to closely monitor their performance as well as all relevant developments in the markets, we remain confident of their effect as a diversifier leading to a more stable, resilient and robust portfolio, particularly during these turbulent times.
This article comes from the latest quarterly BFI InSights (Q4 2016). Read the full document here:
About Felix Zulauf
Felix Zulauf, founder of Zulauf Asset Management, has worked in the financial industry and asset management arena for almost 40 years. He was one of the first successful hedge fund managers in Switzerland, and he is well known for his excellent market timing and market-cycle predictions. He has also been a prominent member of the Barron’s Roundtable for almost 30 years. The Outlook above is a summary of his thoughts conveyed to BFI in our regular meetings and discussions with Felix.-----